The Big Picture–Little Focus on Big Issues

The Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite have all risen to new record highs. It has been a laudable development considering the macro backdrop is still dropping a lot of disappointment on the world.

The more disappointment that is dropped on the world, though, the more it seems central banks are willing to pick things up with additional policy accommodation. That has turned out so far to be a futile attempt to ignite animal spirits in the world economy.

Zero interest rates didn't do the trick. Quantitative easing didn't do the trick. And negative interest rates aren't working. Animal spirits are still missing in action, which is plain to see in GDP growth rates for the world's leading economies.

To be fair, the stock and bond markets have been huge beneficiaries of easy monetary policy, yet animal spirits there aren't like what they were during the dot-com bubble days when you could feel the irrepressible gains of the stock market oozing down Main Street.

Nope.

The animal spirits in the stock market these days are still trapped like zoo animals, partly because nearly half of Americans don't own any stock at all, but primarily because so many people are haunted by the animal spirits of the past and the destruction of wealth that followed in their wake.

Where's the Love?

The stock market may be at record highs, yet it doesn't look as if too many money managers really love this stock market.

High cash levels at mutual funds suggest as much, along with the leadership of the utilities and telecom services sectors. Furthermore, commentary suggesting there is no alternative to stocks makes it sound as if participation in the stock market is more like a forced march than a pleasant walk down Wall Street.

Here we are anyway, though, highlighting record-setting moves and a persistent willingness to buy on stock market dips.

It's quite a situation that is sometimes hard to believe when taking into account that US GDP growth averaged a measly 1.0% in the first half of the year, both political uncertainty and income inequality are rising around the globe, and S&P 500 earnings are on the cusp of declining for the fourth straight quarter, according to S&P Capital IQ.

Those are some noteworthy shortcomings talked about often in the market narrative, but in the context of the big picture, there are other big issues -- really big in some instances -- that seemingly get glossed over with remarkable ease by the forward-looking stock market.

We suspect that is the case, because these big issues have relatively long lead times compared to the stock market's short-sighted view of what the next central bank policy meeting will bring.

Going Big

One of the big issues was laid bare recently in the annual report from the Social Security and Medicare Boards of Trustees.

That report confirmed that, without any legislative changes, payroll taxes will only be sufficient to pay approximately 75% of scheduled Social Security benefits after 2034 through the end of the projection period in 2090.

Meanwhile, it was pointed out that the Medicare Hospital Insurance (HI) Trust Fund will be depleted in 2028, two years earlier than projected, after which time dedicated revenues will only be sufficient to pay 87% of HI costs. This is the fund that helps pay for hospital, home health services following hospital stays, skilled nursing facility, and hospice care for the aged and disabled.

The Supplementary Medical Insurance Trust Fund (SMI), which consists of Medicare Part B and Part D, will remain adequately financed into the indefinite future, but even so, the report concludes that "...projections indicate that Medicare will still face a substantial financial shortfall that will need to be addressed with further legislation." And then there is the matter of public pension funding shortfalls, never mind the unfunded liabilities in some private pension plans that a Citigroup report estimated stood at $403 billion at the end of 2015 for S&P 500 companies.

An FT article in April cited a study by Joshua Rauh, a professor of finance at the Stanford Graduate School of Business, that suggested there is a collective funding shortfall of $3.4 trillion for U.S. public pension funds.

The only way that hole will get plugged, the article notes, is with cities and states increasing their contributions to their pension funds, which would likely be achieved by raising taxes or cutting spending on vital services -- or both we might add. And then there is the national debt, which is at $19.4 trillion, or 105% of GDP, and counting. According to US Debt Clock.org, that is the equivalent of $162,312 of debt per taxpayer.

That is one whopping statistic, especially as we hear both presidential candidates talk about the need to push through fiscal stimulus that is focused on upgrading the nation's infrastructure.

Now does seem like an ideal time to issue long-dated bonds (i.e., with maturity dates greater than 30 years) to finance the upgrade, but it still won't be a free lunch. Interest rates might be quite low right now, but any issuance today is still going to add to the interest payments made on our nation's debt, which will come most likely at the expense of spending on services in other areas or at the expense of taxpayers burdened with higher tax rates.

There is also a demographic problem gestating in low general fertility rates, which refers to the total number of births per 1,000 women aged 15-44. In a recent report from the Centers for Disease Control and Prevention, it was noted that the fertility rate in the U.S. of 59.8 births per 1,000 women in the first quarter of 2016 hit its lowest level on record (dating back to 1909).

This doesn't mean the general population is going to shrink, but it does mean fewer children are being born to women of childbearing age.

That might not sound like a big deal today, but it really is because the children born today are the workers of tomorrow whose payroll taxes will be needed to help pay for things like Social Security and Medicare for older generations who are living longer. The fewer workers there are to cover the costs of the retirement benefits and health care needs of older generations will simply create a greater tax burden and lower standard of living for future generations, assuming a legislative "fix" to cover shortfalls is found through higher taxes and/or cutbacks in spending on other services.

What It All Means

Social Security... Medicare... public pension funding shortfalls -- these are all ticking, liability time bombs and efforts to defuse them are going to carry quite a cost. What the ultimate costs are is indeterminate.

Higher taxes and spending cuts are some likely approaches; bankruptcy filings for some municipalities might be in the cards; or maybe these future problems will just be whisked away to a more distant horizon with some ambitious economic growth, birth rate, and investment return assumptions.

These are big issues that have mattered little in the stock market's mindset. We know as much because the stock market is at a record high and these issues have been lurking out there every step of the way, even featuring a record municipal bankruptcy by the city of Detroit.

Does this mean the stock market has just lost sight of the big picture? We don't think so, but it has been temporarily blinded by the light of easy monetary policy and comforted by a cadre of eleventh-hour solutions in the past that have made big problems go away to be fully addressed at a later time.

If political leaders don't start dealing with these big problems of the future now, they will be destined to arrive in a harmful fashion for all generations and possibly even for a short-sighted stock market one day.

Patrick J. O’Hare, Briefing.com

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